A Funding Stress Indicator Surges to Widest Levels Since May 2020

(Bloomberg) -- Key gauges of money-market risk increased after Ukraine said Russia had attacked Europe's largest nuclear power plant.

Interbank dollar rates jumped again relative to the overnight lending benchmark. The FRA/OIS spread -- a key signal of banking-sector risk -- expanded to 29.7 basis points, the widest since May 2020, after rising almost 10 basis points Thursday. A similar gauge in Australia also advanced, while dollar funding costs for yen investors surged.

Money markets are showing intensifying levels of anxiety this week as traders race for dollars in the wake of toughened sanctions against Russia. The gyrations suggest concern that funding costs for the greenback may continue to increase as the war in Ukraine intensifies.

“The fear that the impact of the war will create a dollar shortage is rippling through the system, especially at the shorter end of money markets,” said Martin Whetton, head of fixed-income and foreign-exchange strategy at Commonwealth Bank of Australia in Sydney. “Australia's markets, like others, are showing some strain as a result, with funding more expensive, though still subdued in the context of the last few years.”

The premium on basis swaps used to convert yen funding into dollars hit 51 basis points on Friday, close to levels reached Monday that were the most since March 2020. During the pandemic crisis, the premium surged to more than 150 basis points.

Australia's FRA/OIS spread reached 16 basis points, a level last seen in April 2020. Australia's bank-bill swap rates have climbed over the past month, widening the gap to risk-free rates, partly driven by the global turmoil.

“For now, we tend to think that the moves in BBSW are the result of the broader volatility in markets,” ANZ Banking Group Ltd. strategists Jack Chambers and David Plank wrote in a note. “Given the higher risk environment, investors may be reconsidering the returns they require to hold short-term debt.”

Moves from the Federal Reserve and other major central banks to normalize monetary policy from unprecedentedly loose settings mean that money markets were already fragile even before Russia's assault on Ukraine sparked fresh turmoil.

Eurodollar Futures

March 2022 eurodollar futures sold off throughout Thursday's session, increasing the perceived level of credit risk, even as signs showed flows were as much about the re-positioning of bets on Fed rate hikes as about systemic dollar-funding stress.

European banking-sector risk has ticked up, with FRA/OIS reaching the widest since October 2020, according to ICAP Ltd. The spread is still much narrower than the levels reached in March 2020. Euro costs for dollar funding have also narrowed by more than 20 basis points from the extremes seen in basis swaps on Monday.